Thursday, March 26, 2009

Watch those baskets: Why Citigroup should be allowed to merge with Wells Fargo

There is a lot of woolly thinking about the right way to regulate banks post this crisis.  The consensus is that banks should never again be allowed to grow to be “too big to fail”.  The right banking system is one in which there are hundreds of banks – all sufficiently small that their failure does not cause systemic problems.  The argument is that Citigroup or Bank of America or whatever is bailed out as soon as it clearly returns to solvency it should be broken up.  

Indeed one of the cases cited for nationalisation is that it is much easier to break the banks up under government ownership than it is when there are private shareholders.

I think this consensus is absolutely cock-eyed wrong – and that the list of the blogging intellegentsia who are wrong on this covers pretty well every big-name economic pundit out there.

The division of American banking into thousands of banks did not help during the 1930s.

More bluntly I think the US should end this crisis with substantially fewer banks – which because they have a high degree of market power should be highly profitable.  The high level of profitability will

(a).  Reduce the incentive for banks to take excessive risks (if you have a goose that lays golden eggs it does not make sense to risk killing that goose), and

(b).  Increases the chance that the banks can work through any problems that they do have (because the underlying franchise will generate enough profit to fill any holes).

The strategy I advocate is to put your financial system eggs in relatively few baskets and to watch those baskets.

The experience of bank collapses

I have spent a bit of time looking at how banks collapse in countries other than the US.  The model I have in head is Taiwan.  Taiwan until relatively recently had about 50 banks.  This is in an economy about the size of a mid-ranking US State.  

The banks were highly competitive and margins were sickly thin.  Bank management respond to the high margins by increasing risk.  Its kind of odd but banks in highly non-competitive markets (eg Australia) have returns on equity of about 18 percent.  Banks in highly competitive markets seem to have equity returns of about 16 percent.  The difference is that in highly competitive markets the banks take more risk to get 16% and they tend to blow up with monotonous regularity.  A blow-up in Taiwan causing something looking like a local recession happens more than once a decade.

Every blow up results in the reduction of the number of banks.  As this happens the level of competition goes down and the profitability goes up.  At the end you wind up with a banking system like Australia – which has four super-profitable banks.  These four banks can survive almost anything because the pre-tax, pre-provision operating profit is so huge.  In Australia and New Zealand the numbers are almost 5 percent of GDP.

I know what I am doing is turning standard economic dogma (particularly amongst conservatives) on its head here.  The standard dogma (questioned by some with financial services) is that competition is almost everywhere a good thing.  But I would have the other view.  My view is that competition in financial services causes massive financial crises.
Much more instructive – and much more familiar to my English speaking readership is the UK recent experience.  The UK banking system was changed by massive competition in mortgages.  UK mortgage margins went to 40bps.  This was extraordinarily low and it was devastating to the UK banking system.  Various banks responded differently to it – Northern Rock levered its mortgage book about 60 times – and then very small changes in spread and credit blew it up (see my old notes here).  HBOS did similarly.  Royal Bank of Scotland bought everything that moved and also levered itself up.  Barclays decided to become one of the world's biggest investment banks.  The problems of the UK banking market were caused by too much competition compressing margins.  

Ditto – the problems in American finance were caused by massive competition from the new (and huge) shadow banking system.  You had mortgage companies spring from nowhere – and start originating huge quantities of mortgages.  Companies like Countrywide – which had very little capital indeed – could originate literally over a trillion dollars in mortgages.  

The financial innovation spread from personal to corporate finance – with all sorts of bizarre credit securitisations.  All of these things reduced margins.  The banks responded to reduced margins not by accepting reduced profit (something that in retrospect would have been the right course of action) but by increasing their risk profile (and hence profitability).  

It was the competition that caused things to blow up.

The counterfactual is Australia.  Australia is very similar to America – except that the consumer was even more in debt.  Our credit card industry was bigger (relative to GDP) as were our mortgages.  Our car loans were substantially lower.  But the consumer here was also fairly close to hocked out.  

However our banks are solvent.  There is only a remote chance that they will become insolvent despite a property boom that makes America's look modest.  They are solvent despite not being well run.  Indeed they are famously bureaucratic and inept.  I once worked for one after having worked for the government.  I can assure you the government department I worked for was far more competently run.  

The banks survive because they are just so profitable.  They are profitable despite being in an economy that should be sour (from indebtedness).  

What I am advocating is – that as a matter of policy – you should deliberately give up competition in financial services – and that you should do this by hide-bound regulation and by deliberately inducing financial service firms to merge to create stronger, larger and (most importantly) more anti-competitive entities.

The last thing you want to do is break up Citigroup.  It would be far better if it merged with Wells Fargo.

What does a post-competition banking system look like?

First the banks are going to be huge.  

They will lay enormous golden eggs for their shareholders.  I hope to be one!

These golden eggs will give the shareholders very strong incentive to act to preserve the banks.  Bob Dylan howled out that “when you got nothing you got nothing to lose”.  Like much of Bob Dylan it is the truth.  And the solution is to make sure the shareholders have something really good – so they have something to lose.

Because the goose lays golden eggs its management should be conservative.  Of course there will be agency problems – with management with incentives to lever up the golden egg laying goose as they will (via cashing their options) have a big part of the golden egg laying goose when it works – and if it doesn't work then the shareholders own the carcase.  So there will need to be corporate reform in such a way that shareholders can better protect their investment from managers.  (Carl Icahn's blog has plenty of worthwhile suggestions.)  

And – as a backstop there should be regulation – and the regulation should be stiffling.  It should limit competition and increase bank profitability.  Captured by the interests of shareholders (but maybe not management) is not a bad place for the regulator to be.

In the end I want this to look like a regulated utility.  Highly profitable and dull as dishwater.  The salaries should also look like a regulated utility (above average – but nothing special).  

The losses from my anti-competitive stance

The first and obvious loss is a generally higher cost of financial services as competition is constrained.  Essentially the anti-competitive strategy will reverse the benefit of cheap and widely available financial services created by the last two decades of financial innovation.  Such is life – that is what the credit crisis is doing – and the benefits of that have been overstated anyway.

The second loss is far more important – you lose the driver of financial innovation.  Competition isn't great because it lowers prices (although it does).  Competition is great because it rewards innovation – and allows companies or individuals who do innovative (usually better) things to thrive and grow.  Companies that don't innovate eventually wither.  This is the “creative destruction” of competition – and it is the greatest driver of capitalism.

Well the last decade and half has rewarded financial innovation above other forms of innovation.  The best and the brightest (and many of them really are very smart) have headed towards the financial sector because that is where the money is.  The best and the brightest do not (with the exception of my business partner*) leave university to join an electricity utility. 

If we remove competition in financial services we remove that chimera called financial innovation.  I argue that is a small loss.  Financial innovation is a chimera because it rewards individuals but creates massive societal risks (as this crisis demonstrates).  Real economy innovation is what drove income and wealth up throughout the 20th Century – and at the moment the failure of financial innovation is stifling real economy innovation through stifling the economy.  My strategy – four to six deliberately anti-competitive banks – is the death knell to financial engineering – and will sharply reduce the salaries of people in that business.  It is bad for New York but it will free the best-and-brightest to do something ultimately more important. 

A call for debate

This is a debate which it is important we have – because almost everybody (outside Australia) thinks differently to me.  That doesn't mean that I am wrong.  I come from a country that has been well served by its four banks – even though they are grotesquely incompetent and bureaucratic.  




John


*The business partner did wind up as CEO of the utility.

40 comments:

JoshK said...

So if we put Fannie and Freddie together we'd somehow be better off? This argument should apply to all industries. Make them big, fat, and in some sense privileged by the government to stave off competition. Then we'd never have any sort of bust.

In the US we have one of the most heavily regulated financial industries in the world. IMHO, this heavy regulation combined with FDIC insurance creates too much complicity on the part of depositors.

I think we'd be much better off getting rid of the FDIC and letting people know that if they want to get a yield on their dollar savings then they would have to invest in a fund that makes some kind of investment. Right now in the US picking a bank to park your cash just boils down to going to bankrate.com and sorting by yield.

And, we have to remember that booms and busts are part of life. This is not the end of the world. We should make sure that the bankruptcy system is ready to quickly resolve competing claims. If there is one area where the government could actually do some good it would be to beef up the court system.

John Hempton said...

Fannie and Freddie failed - but the failure is not very big. It is highly unlikely they will be more than 50-100 billion insolvent.

And they were allowed to be 200 times levered.

If they were only 20 times levered they would have been solvent.

Fannie and Freddie proves my point.

vm said...

One thing to keep in mind that an equivalent pop/bank ratio for the US compared to Aus. would result in 57~58 banks. (303/21)*4 = 57.7. Given the amount of banking just the top ten bank in the US do, is it possible to argue we already have Aus. levels of concentration?

JoshK said...

Just as far as FNM/FRE. They may end up being 500b insolvent. I don't think they could have ever been in the wrap business to that size without the understood government backing. I think the issues now are mostly from their own debt holdings. Our head rates trader gave us a walk-though last week and I don't have the notes in front of me.

But you'll say that the muni insurers were private and they went bust. But I think we have to remember that companies do go bankrupt. Industries fade and change and at the end of this we'll be better off.

I always find it ironic that the left chooses to call itself "progressive" or "liberal" when it's actually very conservative. The underlying theme of your post is that we need to keep the banking system running without significant change and with stability. Keep social security as is, the best part of US history was in the 50's with unionization at its peak, Medicare for all.

Your suggestion applies to all industries and it has the same root. If we had just a few, big, tech companies then maybe we wouldn't have had the NASDAQ boom. We could require capital adequacy tests for tech companies to make sure that we havce stability. Then pass card-check so they all get unionized.

The fact that the government is more involved in running a company doesn't make it less risky. If anything it will just hide the risk better until they have a massive blow up.

I fundamentally believe that the real issue is that there is a better banking system. A lot of the intermediation between depositor and loan can be done better.

John Hempton said...

Kalish

I would love to see your trader walk through of Fannie and Freddie books.

Can you contact me?

Thanks.

John

JoshK said...

John, I'll post something from him tomorrow. Essentially he was saying that their wrap business (original charter) is not really being counted as a major component of the losses and instead it was their own debt holdings that are being considered right now as losses.

I don't think that stops anyone from buying their MBS now, I think the wrap is considered whole regardless.

Anonymous said...

Oh John. I don't agree with you but at least its well written.

You are basically saying reduce competitions so the banks can afford more incompetence. How about just stop saving bad banks until they learn how to manage risk.

babar ganesh said...

what's funny about your electric utility reference is that there is an effort underway to research and fund a high technology electrical 'smart' grid in the united states. obama has started pushing it -- i think there is funding for research in the stimulus bill. i would guess that some of the newly displaced wall street quants will find their way there.

what would be interesting would be to see this effort succeed -- and to succeed to a high level of reliability and efficiency -- and to see people from this effort flow back into banking and finance after 10-15 years doing real, rather than financial, engineering.

or it could be that smart grid technology has some serious hidden risks and masked inefficiencies.

macondo said...

Thought provoking post - though I'm afraid I disagree because I don't believe an oligopoly stops banks from still doing silly things in other markets.

Also, the terrible deposit rates and high fees tend to push investors into seeking more risky places to store their savings.

The market I think of is Hong Kong, where HSBC is by far the dominant retail bank and through the powers of an unchecked oligopoly and a cozy political regime essentially sets the deposit rate for all the major banks.

The great interest margin HSBC has made in HK since the late 1800s are arguably what funded its international expansion. The abysmal rates on deposits must be a reason why HSBC became one of the most (if not THE most) widely held stock in HK - I suspect its dividend often provided a better return than a dollar deposited.

People today in HK are rightly outraged and concerned to see how their 'local bank', whose fortunes were largely built off the efforts of their own sweat, has come back to defraud them with fraudulent recklessness on the other side of the world.

I think the best way to keep the banks close to the 'utility' that they should be, is to re-instate a separation with investment banking practices.
Stefan

peterxyz said...

I wholeheartedly agree - I have always maintained that the only thing worse than banks (and to a greater or lesser extent insurance companies) making obscene profits (as per normal media headlines) is them NOT making obscene profits (ie they're belly up and somehow you're deeply out of pocket - either via bailout or direct losses)

John Hempton said...

I am not going to disagree that the super-profits in Hong Kong funded the HSBC expansion all around the world.

But as long as the HK subsidiary is separately capitalised (no branch or cross border banking allowed) then it is solvent no matter what.

That it is excessively profitable - ah well... Nobody will ever let the HK subsidiary fail.

J

septizoniom said...

i don't think it is the competition that leads to the blow ups. its the implicit backstop of the govenment that leads to extreme risk taking.

Unknown said...

So, basically banks should go back to the 3-6-3 model?

In that case, would we be better off having them run by civil servants? Freddie, Fannie and a couple of new staterun entities? With some small private firms competing in specialized areas. A bit like primary education with the government serving, say, 80% of the market and privates providing the other 20%.

Would you have a feel for how much of a drag on the economy lack of competition in the banking market would be? Would the occasional crisis be worth the innovation and lower banking spreads?

John Hempton said...

Its likely the subject of a follow up post - because I knew this post would promote controversy...

But Hong Kong is the home of 3-6-3 banking - but it is even worse - it is 3-8-3 banking...

And it has hardly stifled competitive spirit there.

Honkers has the most capitalistic of societies (successful) with the most interventionist and anti-competitive of banking regulation - and guess what - it works.

If the downside is the entrepreneurial spirit of Hong Kong then there is not much downside in this proposal...

J

Anonymous said...

they're so profitable that it's the only country to keep the blanket anti-shorts protection. australia and pakistan.
they're so profitable that the government blanket guarantees their foreign debts.

4 banks and 1 airline for 20m people. qantas quality is legendary because of this. you also don't want airlines taking risks, but that doesn't mean monopoly is the answer.

Anonymous said...

A lot more evidence to support you John can be found in Canada. Virtually the same model as Aus. Similar populations, huge profits, very stable.

Canada didn't even have a bank failure in the Great Depression.

Agreene whole heartedly with your post.

Anonymous said...

Canada is another example in support of John's position.

The country has five large banks for 30 million people. The banks are very profitable, but also maintain decent "innovation". For example, my understanding is that adoption rates for internet banking in Canada are far ahead of the corresponding US rates.

In light of the ongoing crisis, Canada has recieved numerous commendations from international regulators for the stability of its banking system.

John is right. It all comes back to what you want out of your banking system. If you are looking for dependable intermediation between savers and investors, than a highly regulated oligopoly is good a solution.

Anonymous said...

John - I was talking to my friend the other day about bank leverage and we got to the topic of 15% ROE for finance firms. What is so magical about the 15% ROE threshold? What's the logic behind it?

Wouldn't it serve the public well if there's regulation on leverage, and investors would look for 11-12% ROE, but with a lower leveraged and presumably less risky banking system?

Anonymous said...

John, one consideration you don't address it the different politcal landscape of the US compared to an Australian or Canadian model. Through out US history, one of the great fears of a large portion of the population has been concentration of economic power in one region to the detriment of another.

While it is an obvious simplification, the desire of agricultural and western states to retain control of their own financial destiny coupled with signifcant power these interests have via the US Senate is a big reason the US banking system has been fragmented throughout its history.

Texas serves as a good example as to what happened when free market failures went unchecked and franchises were unprotected by local governments. Governer Clements and the Texas congressional delegation in the late 80's stayed true to conservative principals and didn't protect its banks from their own failure. When it became apparent that the S&L issues we not a monopoly of dumb cowboys but also threatend California and Mass. banks, Congress did act and we saw the last major bailout before today.

As a result, you ended up with the second largest state and a key economic region without a meaningful bank (Comerica, a recent refugee from Detroit is Texas' largest bank today).

Mergers after the repeal of Glass-Stegal concentrated more power in New York. And the selective policy making recently (NatCity, Wamu get torched, Citi gets saved) has further concentrated financial power to level unprecendented in US history.

Whether this is right or wrong in a globalized world is up for debate, and I like your contribution to that debate. But I would suggest you consider that the politics of further concentration (and even the current level) are simply unacceptable to growing parts of the country (Texas) and the proud and still populated troubled areas (Ohio).

Australia doesn't have a Dallas, and Atlanta, a Cleveland or a Seattle, and it certainly doesn't have a politcal system where a senator from Tasmania has the same say on national finance as the current Senator from Alabama does.

Anonymous said...

Um Citi Bank was a goose that laid golden eggs and management failed to protect it. Your whole argument completely ignores what just happened.

Yes there is economies of scale in banking but there is also disutility to scale when companies are so large no one person could possibly manage it as was the case with Citi. Chuck Prince's idea of risk management was "when the music plays you must dance". He apparently believed that Citi was so large you could do anything. That somehow credit enhancement of structured finance could substitute for lack of basic underwriting standards. This idea has been completely discredited.

Still don’t believe me about scale? I think you will agree that Robert Rubin is an extremely smart man. Yet even he could not prevent the issues at Citi. Why? Could it be that Citi was so large that Rubin's radar could not detect it. In order to have detected it you needed to have been extremely focused on that particular segment but with some many segments to watch because of Citi's scale, that proved to a very difficulty task ultimately a failing one.

You have to admit there is a limit to scale. We can argue where that limit is but it exists. I would argue that it exist somewhere south of Citi's scale. After all it was the large institutions were the ones most affected by implosion of the RMBS market.

Now don’t get me wrong I want large profitable banks too, but they needed to be small enough to be manageable.

Also assuming that too-big-to-fail banks will never fail again ignores what just happened. If not for the US government, Citi would have failed. If you had larger banks during the Great Depression, you would have just had larger failures instead of a bunch of smaller failures.

FDIC saved us from having bank runs that could caused a Great Depression but imagine if FDIC did not exist today. Do you really think size would have saved Citi and BOA. They could barely survive this Cat 2 Hurricane let alone a Great Depression Cat 5.

Anonymous said...

Agree with your logic, and US administration is actively pushing banking sytem toward public utility model as we speak. Might be a few years before innovators leave the sytem and the risks crank down, but in the mean time net interest margins have gone through the roof.

Have you seen BofA's buying activity in MBS? Getting ahead of future TARP participants? Might even experience markups six months out while they collect 20%+ yields on the junk-priced paper.

You have an opinion on how fast they can pay back Gov't preferreds?

Anonymous said...

Virtually every emerging market has the type of banking structure that John proposes: dominance by a handful of large banks. We all know how that tends to work out.

Of course, those banks are not subject to "hide-bound" regulation. Why not? Because emerging markets governments are stupid? No, although that case can certainly be argued.

No. The real reason is that dominance by a few huge banks leads to crony capitalism. We saw this with the GSE's in the U.S. (how much they will lose, and whether John is right in his assumptions, is far wide of the point). We are seeing it now with TBTF institutions, and we would see it in spades with a Wells Fargo/Citi entity.

By the way, besides the GSE's, there is another highly concentrated industry that also engaged in reckless actions: the bond insurers. Oh also the mortgage insurers. And also the credit card industry. Oh and the auto finance arms of the big three.

Also btw, the falling domino failure of small banks during the Great Depression occurred prior to the institution of the FDIC insurance scheme. One can hardly point to that as an example of what would happen with deposit insurance. Further, banking system ROE's in the U.S. were quite high in prior years, hardly the evidence of destabilizing competition.

Elwood Anderson said...

"They will lay enormous golden eggs for their shareholders. I hope to be one!"

You seem to view most aspects of the crisis as a potential investor. The financial sector has grown to where it dominates other sectors of the economy. Making it more profitable and more immune to failure (too big to fail) will just expand its size even more.

The real problem is that the world is awash in capital, to the point where too much capital is chasing too few investment opportunities. In this situation returns diminish and capitalists look for other ways to sustain their returns. This causes them to take higher risks and use more leverage, leading to the bubbles and their subsequent bursts.

What is really needed is better balance between capital and demand. If more of the national income went to consumers, and less to capital we would have a sustainable system where demand would create more opportunities for capital investment. Short of this the only interim remedy is controls on leverage and risky derivatives and reducing the size of financial institutions to the point where they are not a systemic risk.

Babak Mozaffari said...

John, very interesting post, thank you. I have no expertise in economics but would like to add that Canada, with its 5 big inefficient banks closely resembles Australia. With the exception of some of their investments in US banks, they have held up pretty well through this crisis. Higher banking fees and other inefficiencies in the Canadian banking system are apparent to anyone who lives there but like you say, the risks were well averted.

Anonymous said...

John your argument assumes that the landscape in the US is much more competitive than in Australia. What's the market share for BofA mortgages? How does that compare to the market share leader in Australia. I bet in many ways the US, with the largest economy in the world actually has LESS competition than Australia.

Anonymous said...

I think there's a flaw in the thinking here:

"First the banks are going to be huge... will lay enormous golden eggs for their shareholders...
These golden eggs will give the shareholders very strong incentive to act to preserve the banks."

The stability of the institutions will lower the discount rate, raising the stock price. To see additional gains, shareholders will pressure the big bank to take more risk to increase returns. That risk will lead to failures and meltdowns.

I have to wonder whether there's another factor not mentioned here inducing stability into Australian and Canadian banks.

jult52

Anonymous said...

extraordinary call? is that you stevens? that's pathetic.

Anonymous said...

Ha, I know you read Krugman religiously but if there's a small chance you hadn't caught it ..

http://curiouscapitalist.blogs.time.com/2009/03/23/paul-krugman-is-a-very-smart-economist-not-an-all-knowing-being/

Krugman is an omniscient being!

Anonymous said...

John,

I can see the point of turning the banks into heavily regulated sleepy utilities following the 3-6-3 approach to banking to avoid fresh blowups. The extra cost to society of such a " license to fleece the public" needs closer consideration though. Is it 5% of GDP in Australia? Yikes!

But is making the banks huge the answer? Here in the Netherlands we had four huge banks in recent years, is is three now, yet competiton was quite fierce. It certainly seemed much more fierce then twenty years ago when there were many more banks but the atmosphere was much clubbier and nobody could be bothered to work too hard.

In the US as well, the 3-6-3 model was long the province of small local banks. It is the big ones that were much more competitive and blew up.

Perhaps the banks should be broken up in very small pieces and then we apply your idea of stifling regulation? The financial sector could then consist of lot's of small local players, perhaps to be semimonopolies in their locale, stifled by regulation and with neither the means nor the desire to " innovate".

Regulation could be employed to keep the banks small as well. Any bank with over $1 billion in assets wold be subjected to so much red tape it would immediately dump the " excess" assets to be able to breath again.

Such a system would be unlikely to blow up spectacularly, although the cost of credit would rise substantially and the customer service would probably make the Soviets proud. Would it be worth this cost?

Anonymous said...

Not Stevens, no. Don't like the name? I think it sums up the situation nicely.

Mike T said...

John,

Do you think it's possible to prevent competition in today's world? I would argue that technological advances--especially information technology--allowed the ascent of securitization and much other financial innovation.

We cannot turn the clock backwards. If you try to regulate the hell out of the formal banking system and prevent competition, wouldn't we just form an even larger shadow banking system where more risk taking is allowed, therefore boosting ROE's even further?

And wouldn't the shadow banking system take rents away from the super-regulated formal banking system, thereby rendering them even less competitive and more vulnerable than before?

Therefore, the only solution is to comprehensively regulate not only formal banks, but also hedge funds, I-Banks, private equity, insurance companies, CDO's, CLO's, ARS's, CMBS's, CDS's, AND ANY OTHER YET-TO-BE-INVENTED vehicle or instruments.

If regulation lags the creativity by these actors, regulation will fail, and we'd have yet another crisis.

In short, I don't think the disintermediation of the current banking sector can be prevented in the long run, because it's not just a temporary burst of insanity in the economy, but a deeper structural force driven by real technological innovation.

What do you think?

michael webster said...

John,

This is an interesting article.

However, I think that the US has some constitutional difficulties in replicating the Canadian banking law.

Our banking laws are federal, making it easier to have a small oligopoly to oversee.

We also have to thank our previous finance minister, Paul Martin, who raised capital requirements when the banks were allowed to purchase brokerages. This was in the face of complaints by the Canadian banks that they needed lower capital requirements to compete with the US.

Anonymous said...

Um Simon Johnson's view that we need small banks is based on the fact that big banks have so much money that they capture their regulators (and or those who write the laws the regulators have to follow). So you don't even address the most prominent argument for breaking up the banking system.

gz said...

well, I do not know about Taiwan, but Italy is a much bigger economy, 1.3 trillion $ and a case of VERY LOW COMPETITION and as close to oligopoly as you can find outside the textbook definition. So, yeah, they do not costed as much as UK banks to governemnt, but in the last 30 or 20 years costed billions to business and consumers in additional costs and inefficiency. A massive transfer of wealth toward financial services at the expense of industry. How do you mesure 30 years of oligopoly costs ?
And they are not bloated and backward companies, everybody in management is from McKinsey. Also, you theory can be contradicted with many examples, German regional banks that are stare owned messed up and to bailed out, was there too much competition ? I doubt they belong to the german states

It is less expensive to keep interest rates higher John, all this mess comes from artificially low rates plus political pressures to lend too much in the US and UK and the euro effect in Spain, Ireland and Est Europe. You do not need to come up with the beauty of monopoly in finance

John Hempton said...

Anonymous said -

Um Simon Johnson's view that we need small banks is based on the fact that big banks have so much money that they capture their regulators (and or those who write the laws the regulators have to follow). So you don't even address the most prominent argument for breaking up the banking system.

My response

I have not evaded that argument before. I WANT the banks to be captured by the regulator - provided that capture allows them to deploy MORE capital and high returns.

This is the way utilities are captured by the regulator.

Regulatory capture leads - in the utility case - to gold plating of risk management.

That is what I want here.

John

Anonymous said...

Your counterfactual is that heavily indebted Australia is and will continue to be fine because their banking system is a highly profitable oligopoly. At first I thought you were mad but I agree there is some logic to what is otherwise the utility argument. The Australian banks can be congratulated for largely staying away from the toxic assets. I’m not sure if that had more to do with better bank regulation, risk officers, or the fact that dodgy bankers peddling the toxic waste could sell all they wanted to American and European stuffee banks without the long flight to your fine country.

However, is it also possible that the Australian banks were insulated from the crisis as a result of the commodities boom that masked the underlying debt problems? What happens if the Chinese economy continues to contract and they stop spending billions on Australian raw materials? I hope large unemployment and debt defaults do not occur but if they do, are you saying the Australian banks would be able to weather the storm? If so, you’re point is made although I think you underestimate the costs. Yes, it will be good to return rocket scientists to NASA and rid the world of financial engineers. However, I for one would not look forward to 9-3pm branch opening hours, long bank queues with indifferent customer service at best, and high service charges. I remember the highly protected stockbrokers who did nothing and charged 3-5% trading commissions. There are many examples of where financial deregulation has worked wonders. Obviously lack of regulation has failed us now but let’s not turn back the clock to the 1970s and forget all that we’ve learned.

John Hempton said...

I had that backwards. slydexia lures ko.

I want the regulator to be captured by the bank. that is a strength - not a criticism of my proposal...

J

Anonymous said...

Israel is another example -- few banks, highly bureaucratic, the smart people don't want to go work for banks, they want to start high-tech companies.

Anonymous said...

The situation in Europe suggests that we also need to think about the size of the region. Do you have a limited number of banks in the Netherlands ... or a limited number of banks in Europe? A stable situation in a small area may still create an unstable situation in a larger region. Perhaps the solution is to only allow a few number of banks to operate across countries, banks where regulators have come to an understanding about how to regulate / rescue these banks.

Anonymous said...

One of the great lessons that we must take away from this crisis is that predictability only goes so far. The world seems to follow a pattern for a time, sometimes a very long time until it doesn't any more. Call it fat tails, call it six sigma events, whatever, the unimaginable can and does happen.

Because we have a handful of countries that have a small set of highly regulated banks and that has worked well does not mean that is the right model. First of all, is there really a big enough sample countries, banks and time to conclude that?

But that does not really matter, what matters is that in a world where there are a much smaller set of mega banks, they can easily move from too big to fail to too big to save. And too big to save not only brings down financial markets, it takes down the host country too. If that were to happen to the US, it might take down the whole world with it.

Greg

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